'Free' cash may be costly

Don't get carried away by inducement of cash-back mortgage offers. Stephen Pritchard explains the snags

Walking over the threshold of a new home, and finding a cheque for £6,000 or more on the doormat sounds like a dream come true. Few home owners would turn down the chance of extra cash at what is always an expensive time.

Walking over the threshold of a new home, and finding a cheque for £6,000 or more on the doormat sounds like a dream come true. Few home owners would turn down the chance of extra cash at what is always an expensive time.

That additional cash is easy - and perfectly legal - to come by. But, as with everything in the property market, it has its price.

At any one time some eight or nine mortgage lenders will be in the market with a "cash back" deal. Take out a loan, and a few weeks after completion, the bank or building society will send out a cheque for several thousand pounds.

One deal currently being heavily advertised is from the Chelsea Building Society, offering a cash-back of up to 6 per cent of the mortgage amount.

With the average house price in the UK hovering around £150,000, and the average mortgage around 80 per cent of purchase prices, this amounts to a cash sum of £7,200.

According to the financial researchers Moneyfacts, Tipton and Coseley Building Society offers cash-back up to 8 per cent, with a six-year tie in. Northern Rock offers a cash back of 10 per cent, although the borrower is tied to the lender for a full 10 years, at the bank's standard mortgage rate of 6.84 per cent.

With costs such as legal fees, stamp duty and valuations, not to mention moving expenses, the idea of a cash lump sum is attractive. But buyers should be aware that lenders offering cash-back will aim to recoup that sum, and more, over the lifetime of the loan.

Taking the Chelsea mortgage as an example, borrowers who want cash back are tied in to the building society's standard variable rate of 6.74 per cent, for five years. Elliot Nathan, a mortgage adviser at brokers Charcol, says: "In a rising interest rate environment, there are more competitive deals out there than cash backs."

In fact, a cash-back mortgage could be almost twice as expensive as a market-leading loan without such an incentive. Cheltenham and Gloucestershire, the mortgage arm of Lloyds TSB, offers a loan with a cash-back element of 3.75 per cent for mortgages over 95 per cent of the purchase price, rising to a 5 per cent cash-back for loans of 90 per cent or below. The lender's standard variable rate is 6.5 per cent, but the tie, as with Chelsea, is for five years.

In a variation on the cash-back idea, West Bromwich Building Society is offering a free Rover car, in return for a five-year commitment to pay the society's standard variable mortgage rate of 6.79 per cent.

According to Mr Nathan, Charcol does not usually recommend a cash back mortgage, due to the long ties to high interest rates.

But for some buyers, a cash-back deal can be one way to raise a higher mortgage than would otherwise be possible. A borrower who takes out a 95 per cent mortgage, with a 6 per cent cash-back, is effectively borrowing 101 per cent of the property's value. And there is the perceived bonus of not needing to prove an income to support the 101 per cent loan, nor to pay interest on the additional 6 per cent.

But advisers suggest this is an expensive miscalculation. In almost all cases, a buyer would be better off taking out an ordinary 100 per cent mortgage - brokers recommend Northern Rock - as the interest rates are lower and lock-ins will be shorter, too.

"A lot of people take out a cash-back mortgage thinking that they can buy a new kitchen or car, but they do not think how the lender makes the money back," Nathan cautions.

A possible exception is Bristol & West's 6 per cent cash-back mortgage. This is at the lender's standard variable rate - at 6.84 per cent one of the most expensive on the market - but the tie is only for three years.

"If you take this deal and want a 95 per cent mortgage, you could look at it as a 2 per cent discount on each year of the tie in," says Nathan.

"This makes for a standard variable rate of 4.84 per cent, which is market leading."

But this requires discipline. The "discount" only works if home buyers put the cash back on deposit and use it to reduce the mortgage at the end of the tie-in.